We visit Nerdwallet from time to time to answer questions from readers looking for financial advice. One recent question was from a single mom who’s buying a new house and is thinking of keeping her old house as a rental property. She wanted to know if it was a good idea to sell most of her stocks and use the proceeds to buy the new house rather than selling the old one.
This question is not uncommon. We have a number of clients who have invested in rental real estate. The answer is not clear-cut and depends to a large extent on the individual. Are you are a handyman and love to work on carpentry projects? Or are you a single mom who’s disappointed with her stock market investments?
In the run-up to the Great Recession, lots of people got into real estate, flipping houses for a quick profit. For many people that experience ended in grief when housing prices collapsed. However, many people view real estate as an investment rather than a place to live.
So what are the issues involved? Here’s part of my answer (edited):
You have to take taxes, liquidity and return on equity into consideration. First, when you sell your stocks you will have to pay capital gains taxes on any profit.
The second issue is the fact that while stocks are liquid (easy to sell) a house is not liquid in case you have to sell to meet a financial emergency.
The third thing to consider is what the return will be on the equity on your rental property. The rent you receive is not all profit. From this you have to deduct taxes and maintenance. Then there’s the problem of actually collecting your rent: some tenants won’t pay on time – or at all – and how do you evict them? And when people move you will have to repair and paint to get it ready for the next tenant. Unless you’re handy you may have to pay a company to manage the property for you, which reduces your income. Finally the return on real estate has actually been lower than the return on stocks over long periods of time.
On the plus side, you can view free cash flow from rents as similar to dividends from stocks. And there are tax benefits from deprecation on rental property.
The bottom line, there are benefits to owning commercial real estate, but there are also drawbacks. Once you make a commitment to owning rental property, there’s no easy way out. People should think long and hard before plunging into this market.
Arie J. Korving, a CERTIFIED FINANCIAL PLANNER™ professional, has been delivering customized wealth management solutions to his clients for more than three decades. Prior to co-founding Korving & Company, he was First Vice President with UBS Wealth Management and held management positions with General Electric.